After paying off a $ 1 billion debt in July from reserves, the government had only enough dollars to cover less than two months of imports. The nation buys wheat, sugar and powdered milk from abroad and, with the Sri Lankan rupee down 7.3% this year, the import bill is skyrocketing, fueling inflation and raising concerns regarding panic buying and hoarding.
“For investors, it’s about when, not if, they run out of foreign exchange reserves,” said Nivedita Sunil, senior emerging markets analyst at Lombard Odier in Singapore. “If you see where bonds are trading, they are clearly telling you that they no longer have a longer view.”
Sri Lanka’s foreign exchange reserves rose 26 percent to $ 3.55 billion last month, after the country converted the IMF’s Special Drawing Rights, which the South Asian island nation received on August 23, in US dollars, the central bank said in a post on Friday.
As authorities say they will repay $ 1.5 billion in foreign bond payments due in January and July, a Bloomberg gauge of the one-year default probability has risen by nearly 20 percentage points, to reach the highest level in Asia at around 28%.
Government revenues are well below its target as pandemic brakes are hurting economic activity, Finance Minister Basil Rajapaksa told parliament on September 7. With a third wave of Covid-19 crossing the island, the administration has taken increasingly drastic measures to deal with the crisis, from the declaration of a state of emergency to the seizure of rice stocks private mills. Policymakers have prolonged lockdowns, raised interest rates, restricted imports and asked banks to offer foreign currency loans. Weligamage central bank governor Don Lakshman will step down on September 14.
The IMF has not received a request for financial support from Sri Lanka, Masahiro Nozaki, head of mission for Sri Lanka, said in an email. “We are ready to discuss options if necessary. We continue to closely monitor economic and political developments in Sri Lanka. ”
Emergency measures are needed “to give legal support to the end of hoarding.” But with emergencies and sudden lockdowns come rumors and panic, which creates oversupply, ”said Adrian Perera, Managing Director of Lanka Rating Agency. “Rates will have to be raised again this year to keep inflation under control and support the rupee.”
Travel restrictions have taken a toll on the tourism industry, which contributes around 5% of the total economy, while a prolonged lockdown in an attempt to stop the spread of the delta variant has hurt trade and commerce. ‘industry.
Among President Gotabaya Rajapaksa’s emergency measures adopted by parliament this week was the appointment of Major General NDSP Niwunhella as Commissioner of General and Essential Services, giving him the power to requisition the food supply and regulate prices. to “protect the interests of consumers”.
Opposition lawmakers have decried the move as an attempt to expand the president’s power, arguing the crisis could be addressed through existing legislation.
The emergency rules allow the president to “suspend civil liberties, arrest and detain any citizen without a court order, suspend the laws of the land, enter any premises without a court order, and seize private property, “lawmaker Eran Wickramaratne for the main opposition Samagi. Jana Balawegaya party declared in parliament. “No president should be given more power than is necessary to fulfill his responsibilities.”
The new rules were adopted quickly. Officials on Wednesday seized stocks of rice from mills in Polonnaruwa district, one of the country’s main producing regions, in order to distribute the grain under a government price control system, according to the government. Authorities accused the factories of hoarding the supplies.
The next day, the government introduced a 100% cash margin for letters of credit on imports of 693 items, including chocolates, dairy products, wines, cosmetics, clothing and electronics, and banned banks to extend credit to buyers to meet liquidity. requirement.
The measures come on top of capital controls imposed earlier this year to limit the amount of foreign currency leaving the country. To bolster reserves, the government has also asked banks and institutional investors to offer foreign currency term loans by September 22, in multiples of $ 50 million.
The swap line with China and another with Bangladesh, as well as funds provided in August by the IMF through special drawing rights – a facility offered by the fund to boost global liquidity – are expected to cover dollar needs. Sri Lanka until the end of the year at least and allow according to Ek Pon Tay, senior portfolio manager at BNP Paribas Asset Management in Singapore. But in the “medium term, firm energy prices and the impact of the pandemic on tourism income pose problems in rebuilding foreign exchange reserves”.
Sri Lanka has a total of $ 3.6 billion in foreign debt maturing in 2022, Fitch Solutions calculates.
With foreign exchange reserves depleted and inflation now at 6% – the upper end of the central bank’s target range – investors are bracing for further rate hikes. On August 19, the central bank unexpectedly raised its policy rate for the first time since late 2018, saying falling credit costs had boosted imports more than exports, widening the trade deficit.
The rate hike helped Sri Lanka dollar banknotes erase their monthly losses and gain 2.9% in August, the biggest increase in Asia, according to a Bloomberg index. But that may not be enough.
Fitch Solutions predicts that the central bank will hike rates by an additional 50 basis points this year, but that will not solve Sri Lanka’s structural challenges as companies are aware of the dollar shortage. Last month, S&P Global Ratings downgraded the outlook for Sri Lanka’s CCC + rating to negative, fearing that attempts to increase reserves might be insufficient.
Sunil at Lombard Odier says the government needs a longer term solution. “In our opinion, this cannot happen without an IMF program. ”